Tax Penalties Accrued More than Three Years Before Bankruptcy Filing Date Are Dischargeable, Court Rules

Federal bankruptcy law allows debtors to discharge tax penalties if they meet certain criteria. The Internal Revenue Service (IRS) may penalize individual taxpayers for failing to file a tax return by the April 15 due date, 26 U.S.C. § 6651(a)(1). These penalties are dischargeable in bankruptcy if the “transaction or event” that resulted in the penalty happened at least three years before the filing date. 11 U.S.C. § 523(a)(7)(B). A California bankruptcy court recently considered when the “transaction or event” leading to penalties for a late-filed tax return actually occurred. The court agreed with the debtor’s argument, which placed the event more than three years before the filing date. In re Wilson, No. 12-11995, Adv. No. 14-1106, memorandum (Bankr. N.D. Cal., Feb. 25, 2015). The federal government is appealing the decision.

Individual and family federal income tax returns for a particular tax year are due on or before April 15 of the following year, but a taxpayer may obtain an extension of the due date to October 15. The debtor in the present case obtained this extension for tax year 2008, but he did not file the return until 2011. The IRS imposed penalties under § 6651(a)(1). The debtor filed for Chapter 7 bankruptcy in July 2012. The assets recovered by the trustee were sufficient to pay the debtor’s 2008 tax but not the penalties. The debtor then claimed that the penalties were subject to discharge.

In a motion for summary judgment, the debtor argued that the event leading to the imposition of penalties by the IRS occurred on April 15, 2009, the due date for his 2008 tax return. Since this date was more than three years before he filed for bankruptcy, he claimed, the penalties were dischargeable under § 523(a)(7)(B). The federal government argued, however, that since the debtor had obtained an extension, the penalties were not imposed until October 15, 2009, less than three years before the bankruptcy filing date. The court, somewhat incredulously, noted that this was a matter of first impression in the Ninth Circuit.

Both sides cited numerous cases in support of their arguments, but the court observed that none of them dealt with the exact same situation as this case. The debtor mainly relied on McKay v. United States, 957 F.2d 689 (9th Cir. 1992), which dealt with penalties imposed by the IRS for fraud under 26 U.S.C. § 6653. Although the facts were distinguishable from the present case, the court held that the ruling was applicable. The cases cited by the federal government, on the other hand, were “merely dicta as to the issue before the court.” Wilson, mem. at 2.

The Ninth Circuit held in McKay that, based on the language of § 523(a)(7)(B), any “penalty imposed on unpaid taxes accruing more than three years before the filing of the bankruptcy petition is dischargeable.” McKay, 957 F.2d at 693. Personal income tax debts accrue on the April 15 following the tax year at issue. Applying McKay, the court held that April 15, 2009 was the relevant date and that the penalties were dischargeable.

Bankruptcy attorney Devin Sawdayi has practiced in the Los Angeles area since 1997. We help individuals and families use the the Chapter 7 and Chapter 13 bankruptcy processes to repair and rebuild their finances. Contact us online or at (310) 475-939 to schedule a free and confidential consultation with an experienced financial advocate, who can help you get started today.